Invest your emergency funds
QUESTION: IS A TAX-FREE INVESTMENT GOOD?
Whichever product you choose, you should be able to access it when necessary.
AMoneyweb reader asked: I have managed to build an emergency fund of R69 000. I am facing possible retrenchment as the business is not doing well. Would it be advisable to invest a percentage of this fund in a tax-free investment while looking for new employment? Which route should I follow?
For the benefit of other readers let me take the time to summarise the structure of tax-free savings accounts (TFSAs).
TFSAs were introduced to encourage more South African taxpayers to save. When an investor has capital invested in a TFSA the growth on this capital is not taxed.
Capital growth would be in the form of interest or dividends earned and capital gained.
TFSAs are offered by the banks, where they are interest-bearing investments, and unit trust-linked companies such as Allan Gray also offer these investment products.
There is no limit to the amount of capital that one can hold in TFSAs but there are limits to the amount one can invest.
The annual contribution to TFSAs is limited to R36 000 per annum or R500 000 total over the investor’s lifetime. If one has over time invested R500 000 in a TFSA and this then grows to R1 million, the R500 000 that the investment has grown by would be tax-free. Investors should be careful not to go over the annual contribution limits as the penalties on exceeding the R36 000 per year are quite onerous.
There is no minimum period that the TFSA must be held by an investor, nor is there a limit on how much can be drawn from such an investment account per year.
Considering the above, a TFSA is a good way to save and grow capital over time in a flexible way.
Let’s take into consideration that you may be retrenched. Whichever product is utilised to store all or part of the R69 000 capital sum you have accumulated must be able to be accessed quickly if required. Further, it should be short-term at least, and not be invested in such a way that it is exposed to the volatility of the listed share markets.
Taking the above into consideration, it would be a good idea to use a TFSA for the maximum of R36 000 of the R69 000 capital sum. I would advise you to consider a TFSA offered by a unit trust-linked product provider. However, in order to allow for this period where there is a possibility of retrenchment, I would consider selecting a money market or income fund as the underlying fund selection.
Income funds or money market funds will be able to generate a return equal to or higher than a savings account without the volatility of an equity fund. This ensures that the maximum capital is available should it be necessary if the retrenchment possibility becomes a reality.
Should it in time become clear that retrenchment is no longer a possibility then the underlying fund/s utilised in the linked product TFSA can be switched into funds with a longer-term horizon, such as multi-asset class funds or even equity funds.
Consider selecting a money market or income fund
Mauro Forlin is a certified financial planner at Global & Local Asset Management